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Weathering the storms of a volatile stock market

OK, let’s get a grip. While the recent stock market performance is bringing the doom and gloom purveyors out of the woodwork, it doesn’t mean we have to avoid wood paneled rooms. It’s reasonable to question our commitment to being long-term investors when most of those running for president are trying to make the case that the country is going to hell in a hand basket. It isn’t, but a stock market experiencing a long-overdue correction just throws gasoline on a perceived fire.

While turbulence like this can try our patience, it’s wise to keep Warren Buffett’s axiom in mind: “Be fearful when others are greedy; be greedy when others are fearful.” “Greedy” in this context doesn’t mean snapping up shares of this era’s bubble stocks in their current swoon. After all, buying any one of them might be the equivalent of catching a falling knife. What current events do illustrate and reinforce is the extent to which basic strategies lead to long term success.

Take, for instance, the role of dividends in helping reduce the down side of a market correction. The S&P 500 has dropped about 12 percent since the start of the year, but mutual funds focusing on stocks paying high dividends have dropped just 9 percent over the same period. These are funds whose dividend yield is currently at 3 percent per year while the S&P’s dividends average just slightly over 1 percent. If nothing changed between now and the end of the year, the net loss on the dividend-focused fund, would be just 6 percent assuming the dividend steam was reinvested.

A 50/50 mix of dividend-paying stocks and interest-paying bonds has dropped by just 7 percent and the combined yield is about 4 percent. Again, assuming no growth in share price for the remainder of the year, the next loss after reinvested interest and dividends would be 3 percent in this example. Nothing to lose sleep over.

When interest rates rise (someday) prices on bonds that pay today’s older, lower interest rate will fall until the bonds are replaced (returning to their original value) when they mature. Then they are replaced with new bonds at the new higher interest rates. While that’s so with bonds, one school of thought expects this to happen with stocks that pay high dividends for the same reason. High dividend stocks such as those of utility companies perform like bonds to some extent. If interest rates rise, their stock values can drop temporarily, but unlike interest on bonds that is locked in until maturity, the dividends per share can be expected to rise with inflation.

These changes in capital values of stocks or bonds are only a problem for people who were planning to do something else with the money --- like spend it --- or for someone foolish enough to think that they can time the market profitably by second guessing future movements of interest rates. The rest of us, we long-term investors, can be content to sit on our hands and let events unfold. The matrix of influences is far too vast to predict the short term future with any certainty. No professional has ever consistently predicted future interest rates. The Wall Street Journal, and countless other prognosticators, have been predicted that interest rates were sure to spike up leading to the temporary loss of capital in bond funds described above. That WSJ editorial was published 8 years ago. Investors heeding that advice and moving to cash back then have experienced a huge dollar cost of a lost opportunity.

This is not to make light of our current correction, because every downdraft in market values is triggered by some combination of dire warnings that can get under our skin. Such warnings always sound plausible even though, in the last 39 years, we have had only two calendar years where the market lost more than 20 percent. With that in mind, I remarked at the market’s most recent historic high that it might be wise, psychologically, to pretend that our account balances were about 20 percent lower than the dollar amount on the latest statement. The average snap-back following each low point of the 8 crashes since 1970 has been a gain of 39 percent in the following 12 months. Armed with facts like this, even a neurotic long-term investor can weather a perfect storm.

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